Economics and politics - comment and analysis
20. November 2018 I Heiner Flassbeck I Globalisation and Development

Brazil: Just confusion or complete insanity? – 2

The mistakes of the last Brazilian governments, including the governments of the Labour Party, result primarily from fears of capital markets and a global system that gives these markets immense power over governments.

In Brazil, after the recession of recent years and the transition to a new conservative government (under President Temer, who succeeded in dismissing Dilma Rousseff, the actual elected president), there has been a dramatic turnaround in economic policy. The conservative government was convinced that only a strict austerity course by the state could create the conditions for new economic growth, because government debt seemed to have gone out of control during the recession. For example, the government was or- dered not to increase state spending for several years.

Indeed, Figure 1 shows that the annual new government debt has risen sharply since 2014. At its peak in 2015, new indebtedness exceeded ten percent of GDP – a figure comparable to that reached by the US after the major recession of 2008/2009.

Figure 1: Deficit of the Government


Such a development, however, is absolutely normal in a severe recession and – under reasonable economic circumstances – can never be avoided. Tightening the fiscal brake when all other sectors are already on the brakes is absurd and stupid.

Moreover, the total debt of the Brazilian state is still within a range that is by no means dramatic, even by conservative standards, and is again below the level of the US (Figure 2).

Figure 2: Overall Government Debt


But just as in the northern industrial nations, a question of fate is constructed out of it in interested and uninformed circles and the population can then easily be persuaded that only a radical political turn can prevent the “downfall”.

Brazil is even particularly vulnerable to debt panic because it has a chronic interest rate problem. The interest rates at which private banks lend money have been absurdly high for decades and no government has managed to bring about a fundamental change. The so-called lending rate, i.e. the banks’ interest rate for loans, has always been 40 to 60 percent over the past twenty years (with an inflation rate of less than ten percent!) in a range that is prohibitive to private investment (Figure 3).

Figure 3: Interest Rates


The deposit rate is also very high at ten to twenty percent, but the banks’ margin can only be described as absurd. The situation is only alleviated by the fact that the state development bank BNDES is an institution that grants loans to companies at halfway reasonable conditions.

However, this does not change the fact that Brazil is suffering enormously from this chronic interest rate problem. As Figure 4 shows, the discount rate, which is significant- ly influenced by the central bank, is also extremely high at well over ten percent. Alt- hough the interest rate paid on longer-dated government bonds is lower, it was still ex- tremely high at almost fifteen percent three years ago in view of the deep recession. On- ly in the last two years has it fallen below ten percent.

Figure 4: Policy Interest Rates


“Currency War”

Brazil has been suffering for several decades from the inability of the political elite to control the country’s monetary system. In the 1970s and 1980s, the country was vulner- able to extreme inflationary developments, which only came to an end at the beginning of the 1990s with the introduction of the real. But then the foreign trade aspect regularly got out of hand. While it was initially a crawling peg (i.e. a planned regular adjustment of the exchange rate to the inflation differential with its trading partners) that failed in 1999 because it ended in overvaluation, Brazil plunged into a dramatic overvaluation situation also when exchange rates were determined by the market and not fought by the Lula government.

Although Brazilian Finance Minister Guido Mantega spoke several times in 2010 that his country was in a “currency war”, the government failed to muster the political strength to counter the various revaluation waves vigorously and convincingly for the markets with the help of the central bank. Ultimately, even under President Lula, the govern- ments always buckled against the argument of the central bank (led by an extremely conservative economist) that intervention in the foreign exchange market was inflation- ary and that a relatively small country like Brazil could not oppose the huge internation- al financial markets.

That was and is nonsense, of course. Switzerland has meanwhile shown that even a much smaller country than Brazil can do this and that the resulting inflation risk is zero. But in Brazil the neo-liberal economists have done a great job and the governments led by the Labour Party have not brought on board the expertise that would have allowed them to convincingly present an alternative to the mainstream in public.

If it had been understood at an early stage that inflation is not a monetary phenomenon, but rather a desperate attempt by workers to secure a share of overall economic progress, monetary policy could have been executed quite differently. But the government should have ensured workers that wages actually rise in line with productivity and the inflation target. This would have benefited domestic demand and permanently eliminated the risk of inflation, which in turn would have paved the way for reasonable interest rates. But none of the governments provided by the Labour Party were able to come to terms with all this, which is why they ended up in the wake of the major overvaluation crisis.

What now? Bolsonaro and Guedes!

The new president of Brazil, according to his own statements, has no idea about economic issues and has therefore brought on board an economic advisor whom he obviously trusts to a large extent. Although he himself is more inclined to assign an important role to the state in society, his economic advisor, Paulo Guedes, has a clear Chicago position and firmly believes that only the market can solve the economic problems.

Whether and for how long this works will be seen, but it was interesting that Bolsonaro, in one of his first statements after the election, suddenly spoke out in favour of exchange rate target zones. After all, that would be a glimmer of hope. But there was even a comment in the Financial Times on this, which was more than absurd. The FT wrote:

„For many economists, such a move would be catastrophic — a freely floating exchange rate is regarded as one of the pillars of Brazil’s economic stability because it allows the currency to act as a shock absorber.“

In view of the Brazilian history with destructive revaluations that came directly from the market, to call flexible exchange rates a shock absorber is the world upside down! This reaction, however, is typical of people defending the neoliberal dogma and shows exactly what kind of opposition every “heterodox” government is facing if it does not have its own strong expertise with which to oppose such nonsense immediately and without compromise.

But Paulo Guedes will certainly not provide this expertise. The man who is proud to have studied in Chicago and helped Chile with his “reforms” under Pinochet is a neoliberal of the hardest kind. But, and this is even worse, he obviously has no idea how and whether neoclassical ideas can be translated into reality. Among many other things, he said recently:

“We are so far from the efficiency frontier that if you keep removing distortions you could have three to four years of rapid growth.”

By “efficiency frontier” he obviously means the combination of labour and capital, where in the typical neoclassical production function one can no longer increase output with- out investing in new equipment (and without using more labour). The idea, which is more than crude, is that it is possible to increase output at all points below this level without investment, if only the market is given the freedom to search for the optimal combination of labour and capital in its own efficient way.

In addition to many other absurd assumptions, there is obviously no such thing like de- mand in this small-minded world. The workers get a fair wage and the capital works at the right interest rate at all times. Of course, the exchange rates on the foreign exchange market are also determined correctly and efficiently at all times. Neither abroad nor at home can there be distorted prices and if there should be, then the state can eliminate the “disturbances” with a few strokes of the pen which prevent the market from moving towards its optimum.

Who has such counsellors, needs no more enemies. The only question left is how quickly this grandiose nonsense as such will show itself in a catastrophic economic result. For a while Brazil can now live off the devaluation again, but sooner or later the market will reward those who are faithful to the market and “give” them an appreciation of the real, which will quickly put an end to the illusions of Mr Bolsonoro and Mr Guedes.

(This is a machine translation of an article that was published on Makroskop – – recently)